Stocks & Bonds


Think Outside the Bank to Boost Yield

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As we move into 2014, it's not getting any easier to collect a satisfying—or even noticeable—yield on your savings. Interest rates on savings accounts, certificates of deposit and money-market accounts will move up slowly this year, at best. It won't matter much whether the Federal Reserve trims its bond-buying program this month or next month, or waits until late in the year. So much cash is sitting idle in banks and other financial institutions that lenders can't jack up rates on loans. And that means they won't need to offer savers a meaningful raise to attract more cash. The best one-year certificate of deposit today pays 1.05%. In a few months, that might rise to 1.15% or 1.25% at best.

See Also: Investing for Income Special Report

Fortunately, skimpy bank rates aren't your only option. Later, we'll offer a wide-ranging menu of investments offering increasing yields. But first we'll set the table with an opportunity to ride rising mortgage interest rates to higher yields.

A 30-year fixed-rate home loan closes now at an average of 4.3%, up from 3.5% a year ago. The easiest way for investors to ride along is with shares of a Ginnie Mae mutual fund. The funds own pools of government-backed home loans and pass interest and principal payments on to investors. Currently, you can capture a yield of close to 3%. That's up a percentage point from a year ago.

Unlike savings accounts, of course, the mortgage bonds' value varies with interest-rate action. During 2013, for example, the share price of Vanguard GNMA (symbol VFIIX) bounced as low as $10.26 and as high as $10.93—reflecting the ups and downs of the underlying securities. The fund's monthly income also changes. If mortgage rates continue to inch higher, this and other similar funds will buy new loans that pay higher interest. That's why Vanguard GNMA's monthly distribution is up sharply since mid 2013. This offsets the declining market value of the fund's older, lower-rate mortgages. So its most recent yield, based on the latest dividend payment, is 2.6% and rising. Total return is 0.6% the past three months.

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If you need more income, you should pursue both interest, which is fixed, and stock dividends, which often go up each year. You can tap into an array of cash flows from business sales and profits, as well as the interest on bonds, loans and mortgages.

Many experts cast several nets with their own family savings. Mary Ellen Stanek, director of asset management for the parent company of Baird Funds, advises her mother, who is in her eighties, to "just walk along" in high-quality short-term and intermediate-term bond funds. This earns her mother about 2%.

By contrast, Stanek's husband, a dentist in his fifties who is a few years from retirement, keeps an even balance between stocks and two higher-yielding and slightly risky bond funds, Baird Core Plus (BCOSX), which pays 2.6%, and Baird Aggregate Bond (BAGSX), at 2.8%. Both funds hold government, corporate and mortgage bonds, with the average maturities 7.1 and 7.0 years, respectively.

Stanek, who has supervised income investments for 34 years, currently likes quality municipal and corporate bonds, and she's confident that the domestic high-yield (junk) market will have another good year provided you don't dig to the bottom of the credit heap. She argues that so many Americans are seeking high yield from corporate bonds, mortgage funds and real estate investments, that the supply is tight, keeping yields down but principal values secure.

This may sound odd given all the handwringing over the dangers of the nation's debt. But Stanek's point makes sense, at least for 2014. Municipal bond issuance was 30% lower last year than in 2012. The Treasury is borrowing less now that the government's deficit is half what it was in 2011. And whenever a top-shelf company issues new bonds, as Verizon did recently, buyers swamp the offering.

So thinking outside the bank is not as fraught with danger as it appeared not long ago. Sure, bonds, bond funds, real estate investment trusts and some high-yielding stocks lost value last spring and summer over fear that interest rates were about to take off. But since July, nearly every decent bond fund and bond alternative, such as Ginnie Maes and property-owning REITs, has risen in value. They begin 2014 in good shape.

Kiplinger's expects interest rates will climb only a little this year and that the economy will grow 2.6% with continued low inflation. Based on that forecast, consider this menu of income investments we expect to be reliable in 2014. Yields are based on the latest monthly or quarterly payouts; total returns cited are for 2013, through December 5.

Yields Up to 2%

With a long-enough CD, you can hit this target. But why lock up your cash for several years when you can reach the same level with a low-cost short-term bond fund? You'll want a low duration—less than two years—so that if interest rates spike, you won't lose much, if any, money. (Based on the maturity of bonds in a portfolio, the duration estimates how a change in market rates would affect principal value.) Consider Baird Short-Term Bond (BSBSX), which yields 1.5% with a duration of 1.9 years. Metropolitan West Low Duration Bond (MWLDX) is equally fine. It yields 1.6% with a duration of just 1.2 years. (If rates go up a full percentage point, your principal should lose 1.2%. That would leave you with a net gain.) Both use government, mortgage and corporate debt.

Short-term municipal bonds and muni funds also have appeal, and not just for the tax exemption. Muni yields often exceed Treasury rates of the same maturity. You can buy noncallable A-rated munis directly for a yield to maturity of 1.5% to 2% for three to five years. Or use a fund such as T. Rowe Price Tax-Free Short-Intermediate (PRFSX) and get a current yield of 1.6%. That's equivalent to 2.3% on a taxable investment if you're in the 28% federal bracket, more if you factor in state and local levies. The duration is less than three years, and 99% of the holdings are investment-grade.

Yields From 2% to 3%

To get here you'll want to add dividends to the mix. Two terrific buy-and-hold choices that often add growth are the twin Vanguard balanced funds, Vanguard Wellington (VWELX) and Vanguard Wellesley (VWINX). Wellington is two parts stocks to one part bonds; Wellesley the reverse. With blue chip stocks' dividend yields and intermediate-term bond yields so close, this pair also converges: Wellington pays 2.4% and Wellesley 2.9%. (Total returns 16.7% and 7.5% respectively.) You get famous stocks such as Johnson & Johnson, Chevron and Microsoft, as well as a barbell-style bond position, which means short-term and long-term high-quality bonds, governments and corporates. These funds are ideal as core sources of income-with-growth. Then you can work in bolder stuff.

An alternative is to combine a general or flexible bond fund (or several) with dividend payers. A class of creative bond funds called unconstrained—or go-anywhere—fits here. Dodge & Cox Income (DODIX), which yields 2.9%, has low costs, a moderate duration of around 4 and a superb record. (Total return through December 5 was 0.2%.) Metropolitan West Unconstrained (MWCRX) yields 2.6% and combines junk bonds with short- and intermediate-term investment-grade debt. (Total return: 2.6%.)

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